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How the Greenspan bubble burst
William Keegan Sunday September 8, 2002 The Observer There was a period during the chancellorship of Nigel Lawson when some Treasury officials favoured the 'spritzer' as a drink. This is neither white wine nor water, but an uneasy combination of the two. The mystery of why officials should have been opting for this strange potion was solved when one learnt that leadership in this matter was coming from none other than the Chancellor himself. This summer, before going on holiday, I noticed that a number of Treasury officials were talking of the crime novels of Raymond Chandler. I don't know whether this was at the suggestion of the Chancellor, but it intrigued me; as I hadn't read Chandler since I was at school, I thought a return to the scene of the crime might make good holiday reading. And so it did - ideal for the necessarily brief bursts of reading that child duty by the pool allows. But for meatier stuff I took Anthony Beevor's Berlin: the Downfall, 1945 and Piers Brendon's account of the Thirties, The Dark Valley. Anything to do with the Second World War puts current problems in perspective, and reminds one why, for all its irritations, the European Union is a good thing and must be built on. But the relentless slaughter of 1944-45 described by Beevor made pretty depressing holiday reading, although it did not quite drive me to try the drink favoured in Chandler's The Long Goodbye: the 'gimlet', 'half gin and half Rose's lime juice, and nothing else'. I do not know whether this will catch on at the Treasury. Perhaps it could be mixed with a spritzer. To explain the Thirties, Brendon naturally spends a good deal of time on the Twenties. And, without wishing to push the analogies too far, one is reminded how closely the boom of the Nineties and turn of the millennium resembled the lead- up to the 1929 Crash and Depression. Brendon's section on this is replete with quotations and rationalisations that could have come straight from the Nineties. The basic belief was that it was a 'new era', and you could forget the old assumptions, rules and regulations: the stock market knew better... Which brings us to the recent apologia by the economic policymaker who was worshipped throughout the Nineties and acquired the status of financial witchdoctor, Alan Greenspan, chairman of the US Federal Reserve. Greenspan recently claimed 'it was very difficult to definitively [sic] identify a bubble until after the fact' and that, in any case, it was impossible to do anything about a bubble, even if it could be identified. This seemed to me to be a revisionist view, because I recalled friends of Greenspan telling me years ago that he was very concerned about the stock market bubble, and indeed used that term. But he would then point out that the very metaphor itself implied you could do nothing about it. You could not 'deflate' a real bubble. Real bubbles could only burst. Can it be that the boom got out of hand, and that appropriate cautionary policies were not adopted simply because policymakers were obsessed with one metaphor that told them they could do nothing? Well, not exactly: the American economist Paul Krugman has tracked down a passage in the published minutes of the Federal Open Market Committee for September 1996, at which the Fed chairman said: 'I recognise that there is a stock market bubble problem at this point.' The solution was 'the possibility of ... increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it.' The timing of this statement was interesting. It was several months before Greenspan made his famous comment about 'irrational exuberance', and that comment itself was made in December 1996, when the US stock market boom of the Nineties was only in its infancy. Now anyone who has read JK Galbraith's The Great Crash will recall the central role 'margin requirements', or rather the lack of them, played in the boom of the Twenties. Bluntly, much of the feverish buying in the Twenties and the Nineties was done on easy credit, and tougher regulation of the financing of stock market activity could have done a lot to limit the damage. This is not of just historical or 'academic' importance. As British economist Christopher Dow made clear in his last work, Major Recessions , history teaches us that 'the bigger the boom, the bigger the bust'. This is a lesson that, to judge from the number of times he has referred to 'the economics of boom and bust', Gordon Brown has fully appreciated. It is abundantly clear from the gloominess of the economic news in the US that the 'bust' phase is far from over. And, given that the rest of the world relied for so long on the US role as 'importer of last resort', there is a limit to which European schadenfreude can offer consolation. For years Europe has been conducting what are known in the trade as 'sub-optimal' economic policies, and now the chickens are coming home to roost. If there is any good news in this it is that as it becomes apparent that one European economy after another cannot meet the rigid requirements of what Wynne Godley and Bill Martin recently termed the 'Instability and Not Much Growth Pact', a more enlightened approach will be forced on the eurozone. This in turn will ease some of the difficulties in the way of any British move towards joining the single currency. This is a source of consolation, not necessarily an occasion for joy. Overinvestment in the US during the boom has begun to produce a wave of price cutting which may be good for those who think defeating inflation is the be-all and the end-all of economic policy, but has serious students - including the Fed - worried about deflation . It was because of the economic misery associated with Depression and deflation that the postwar Keynesian consensus was born: a little inflation was to be tolerated in preference to the economic horrors of the Thirties. But latterly, as the inflation statistics became the obsession of policymakers, the old-fashioned, balanced approach was forgotten. 'Stabilisation policy' was about trying to keep economies on an even keel, avoiding recession or depression, but also avoiding booms in which people lost their senses and everything ended in tears. An acceleration in the rate of inflation should not have become the only reason why policymakers contemplated applying the economic brakes. We are now suffering the consequences of this obsession. ********************************************* http://www.observer.co.uk/economy/story/0,1598,800856,00.html Benny Greenspan's post-bubble blues
William Keegan in Washington Sunday September 29, 2002 The Observer What caught Radio 4's 10pm headlines the other night was - rightly, I suppose - Alan Greenspan's indication to the Society of Business Economists that, while he was concerned about the 'uncertainty' caused by the US plans for an attack on Iraq, he was relatively relaxed about the outlook for oil prices. This was in answer to questions. Most of Greenspan's talk was more the stuff of a good World Service programme - the sort, he observed, that he listens to on short wave in Washington. While at least half his audience must have been concerned that the economic world as they know it is falling apart - deflation in Japan; desperately sluggish growth in Europe; collapsing stock markets and a post-bubble 'correction' in the US - Greenspan, always the arch-conservative, delivered a paean of praise for the wonders of unfettered capitalism; lauded the concept of 'creative destruction'; and reaffirmed, despite all the recent corporate scandals, that he was an unrepentant sceptic of the need for more regulations, even in the financial markets. His theme was that, because all those financial engineers in the financial markets were so adept at spreading and offloading risk, the system had proved remarkably resilient. Nobody asked him whether his complacency about banks also applied to the risks they had offloaded to the insurance business; nor whether, having seen the Nineties financial bubble blow up on his watch, it was time to go back to his first love, the saxophone. Greenspan strikes me as bearing a passing resemblance to the late Benny Goodman, and would surely be able to shore up any deficiencies in his post-bubble pension by starting up as 'Benny Greenspan and the All Stars'. After all he is several years younger than our own Humphrey Lyttelton, and has a similar magic touch with a live audience. One even begins to see historical parallels with the Twenties era of 'boom and bust' which Scott Fitzgerald christened the Jazz Age. Certainly, recent reports suggest that The Great Gatsby has had something of a reincarnation at the country seat of Lord Rothschild, where a gathering of the old and nouveau riche (always remember Fitzgerald's dictum that 'the rich are different from you and me') evidently decided that fiscal and monetary policy were 'impotent' in the face of the Greenspan Bubble's collapse. When I first read the report of the Chateau Lafitte party on which I had unaccountably missed out, I made a Freudian slip and read 'impotent' as 'important'. But no, it was 'impotent'; and even the great Paul Volcker, who preceded Greenspan as chairman of the US Federal Reserve Board, was included among the sceptics. Well, it depends what you mean by impotence. Economic policy can make things worse. Indeed, one of the most important insights I have picked up over the years I have been studying macroeconomic policy (an insight for which I am indebted to John Llewellyn, of Lehman Brothers, who told me in his days at the Organisation for Economic Co-operation and Development) is that, to paraphrase: 'Good policy may not achieve very much, but bad policy can really cause trouble.' One example of seriously bad policy was the terrible game the US administration played with the dollar/yen exchange rate and Japanese monetary policy in the Eighties, thereby exacerbating the problems of the Japanese economy and the 'bubble'. Another was the way extreme free market advisers promised the earth to the former Soviet Union after 1991, giving it the impression that successful market economies were easily achievable, and ignoring much of the history of the last 200 years. Again: while German unification was a great historic event, the terms of the monetary unification - via the one-for-one exchange rate between the Dmark and the Ostmark - created problems for the former East Germany's real exchange rate which are still a burden. Then, just when the Japanese economy had finally recovered from its first post-bubble recession, the government ruined the recovery in 1997 with perhaps the most ill-timed rise in consumer taxes in modern history. Meanwhile, the application of the Washington Consensus belief in rapid 'liberalisation' of markets produced mayhem in East Asia, while tying the Argentine currency to the US dollar made that economy seriously uncompetitive. I referred a fortnight ago to the fact that, long before he made his 1996 'irrational exuberance' speech, Greenspan said he knew how to puncture a bubble; but in the end his belief in the wonders of creative destruction and the financial acumen of the markets, got the better of him. As for the way continen tal Europe became excessively conservative over monetary and fiscal policy before and after the inception of the euro, we are at least seeing a grudging recognition that the Stability and Growth Pact has to be improved. In Britain we suffered severe policy errors in the sado-monetarist phase of the Thatcher government in 1980-81; with the excessively lax policies of the late Eighties Lawson Boom; and in the manner and timing of sterling's entry to the Exchange Rate Mechanism in 1990. In most of the above episodes macroeconomic policy was not impotent; it was all too powerful - in the wrong direction. Now the world faces a crisis of economic confidence, and we are told that policymakers are impotent in the face of this. Perhaps the most important lesson Greenspan and co failed to learn was that provided by the great British Keynesian, Christopher Dow, in his posthumously published Major Recessions (Oxford 1998). So far from being wild expansionists, true Keynesians are moderate and believe in balance. Dow concluded that recessions follow booms, and that the art of economic management is primarily to prevent booms getting out of control. This is precisely what the US Federal Reserve failed to do. Dow did not believe that policymakers could control the business cycle completely; but he did conclude it was possible to reduce the depth of recessions with precautionary measures. There was a case, he argued, for having 'permanent constraints such as a system of lending controls in place [or ready] to prevent a runaway boom.' Unfortunately, such wise precautions did not fit the philosophy of Alan Greenspan, the Thatcher and Major governments or even New Labour. The next best thing, once the recession has begun, is to try to reduce its severity by easing monetary and fiscal policy. Gordon Brown got the Dow message, with his oft-repeated desire to avoid 'boom and bust'. And the boost to public spending here, plus continued low interest rates, mean that, even now, Britain is faring better than many other advanced economies. The British economy is now in such an interesting position that the International Monetary Fund, while urging the US and eurozone to be ready to cut interest rates, and saying the risks around the world between inflation and the generalised deflation were 'more balanced than at any time since the war', sees no need for further rate cuts here. Indeed if the consumer and house price booms go on, the IMF implies rates may have to rise. The former Bank of England chief economist John Flemming, writing in the September issue of the Leopold Joseph bank's Economic Comments , warns that the UK may face public-sector pay. This is because, in the face of the Government's commitment to better public services, the bargaining power of the public sector workers may have increased. Flemming raises the prospect of the Monetary Policy Committee having to raise interest rates should public sector wage demands spread to other sectors, despite the general world economic climate. Pass the Chateau Lafitte! But don't give it to Customs and Excise. They recently poured a large quantity of impounded fine wine down the drain. Told what they had done, officials said: 'We know all about beers and spirits, but nothing about wine.' The 'impotent' policymakers might say the same. |
